Mall REITs: Too Little, Too Late

Summary

  • Pushed to the brink by the pandemic, Mall REITs entered 2020 on unstable footing following a tsunami of store closings over the past decade, and the forthcoming vaccines may be too-little-too-late.
  • Despite improving rent collection and foot traffic, earnings reports revealed that Q3 was another epically-bad quarter with same-store Net Operating Income plunging over 20% and occupancy rates in free fall.
  • It's the end of the road for some: Troubled mall REITs Pennsylvania REIT and CBL & Associates each filed for bankruptcy this month while Washington Prime likely isn't far behind.
  • "Black Swan Times Three." Retail real estate legend David Simon provided some grim commentary on the state of the mall sector, commenting that it's "sad to see what's happened to a good solid business."
  • While the lower-tier of the sector is getting hollowed out, the forthcoming post-pandemic "suburban revival" offers a glimmer of hope for the higher-productivity mall REITs, including Simon Property and Brookfield Property.
  • This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

REIT Rankings: Mall REITs

mall REITs

(Hoya Capital Real Estate, Co-Produced with Brad Thomas)

Mall REIT Sector Overview

Pushed to the brink by the pandemic, Mall REITs entered 2020 on unstable footing following a tsunami of store closings over the past decade, and the forthcoming vaccines may be too-little-too-late to save the lower-tier REITs. Within the Hoya Capital Mall REIT Index, we track the eight mall REITs, which account for roughly $30 billion in market value: Simon Property (SPG), Taubman Centers (TCO), Macerich (MAC), Tanger Factory Outlet (SKT), Washington Prime Group (WPG), Pennsylvania REIT (PEI), and CBL & Associates (CBL), as well as one diversified REIT, Brookfield Property REIT (BPYU), which owns a portfolio comprised of roughly 50% mall properties.

mall REITs

Punished by the economic lockdowns that lingered into late-summer, mall REITs remain lower by more than 40% this year, but have rebounded more than 25% over the past week after Pfizer (PFE) announced positive trial results for its COVID-19 vaccine candidate, a potentially major breakthrough hailed as a "great day for science and humanity." The clock is ticking to get approval and begin distribution, however, as reported coronavirus cases have continued to rise in the United States and globally over the last two months, and some investors are concerned that the recent European-style lockdowns may be coming to U.S. cities over the next month.

coronavirus vaccine

Despite improving rent collection and foot traffic, earnings reports revealed that Q3 was another epically-bad quarter with same-store Net Operating Income plunging over 20% and occupancy rates and leasing spreads in free fall. Mall REITs reported collection of less than 50% of rents in the second quarter and only about 80% of rents in the second-quarter - by far the lowest in the real estate sector. The majority of enclosed mall properties were closed during the peak of the coronavirus shutdowns in late March through mid-May, but all mall REIT properties have now reopened. Despite this, Simon Property commented that it's experiencing ongoing collection issues from "certain larger national tenants, who unfortunately are refusing to pay their contractual rent."

mall REITs rents

Collection rates have improved considerably over the last quarter, but commentary from these REITs suggests that a sizable percentage - perhaps half or more - of missed rents in the second quarter will ultimately remain uncollected. Temporary and permanent store closings and anemic rent collection resulted in a decline in same-store NOI growth of nearly 30% in Q3 for the lower-tier mall REITs, while FFO per share has plunged a mind-numbing 70% through the first nine months of 2020. Retail real estate legend David Simon provided some grim commentary on the state of the mall sector, commenting that the coronavirus pandemic has been a "black swan times two or three" and that it's "sad to see what's happened to a good solid business."

mall REIT ffo growth

As if the retail apocalypse and coronavirus pandemic weren't big enough concerns for the enclosed mall format, these headwinds have been magnified by the sky-high leverage levels of many of these mall REITs. Feeling these pressures, it's apparently the end of the road for some, as troubled mall REITs Pennsylvania REIT and CBL & Associates filed for Chapter 11 bankruptcy protection last week. For PEI, the filing is a continuation of its previously-announced restructuring plan that began in mid-October while CBL's filing is an extension of an agreement reached with debt holders announced in mid-August. We believe that Washington Prime - and perhaps even some of the mid-tier REITs - may not be too far behind either given the nosebleed-levels of debt on these REITs' balance sheets.

mall REIT balance sheets

We've remained bearish on the mall REIT sector and believe that the coronavirus pandemic further amplifies the significant secular headwinds facing the enclosed mall format and accelerated store closing decisions. The pace of store closings is expected to increase substantially in 2020, and following a similar pattern as 2019, the market share loss and pace of store closings will likely hit the traditionally mall-based retail categories especially hard, the majority of which fall into the dreaded "non-essential" category and those that have struggled to adapt to the increasingly digital retail landscape. While the lower-tier of the mall REIT sector is apparently getting hollowed out, the forthcoming post-pandemic "suburban revival" offers a glimmer of hope for the higher-productivity mall REITs including Simon Property, Macerich, and Brookfield Property.

e-commerce market share

Mall REITs were a favorite of yield-hungry and value-seeking investors for much of the past half-decade, but it's tough to pay dividends if you don't collect the rent. The three aforementioned higher-productivity REITs - Simon, Macerich, and Brookfield - are the only mall REITs that continue to pay a dividend after the remaining five REITs eliminated their payouts earlier this year. We've now tracked 65 equity REITs in our universe of 170 REITs to have cut or suspended their distributions since the start of the pandemic, including the majority of retail REITs. Not all REITs are struggling, however, as 40 equity REITs have announced a dividend increase in 2020, primarily in the "essential" property sectors - technology, industrial, and housing REITs.

reit dividend cuts 2020

Deeper Dive: Mall Fundamentals Amid Pandemic

We've already seen bankruptcy filings this year from J.C. Penney, J. Crew, Neiman Marcus, and Modell's, among others, and there are likely more to come as the retail landscape continues to change and punish those who were slow to adapt. Below, we present our framework for analyzing each property sector based on their direct exposure to the anticipated COVID-19 effects, as well as their general sensitivity to a potential recession. We note that mall REITs fall into the "High" category in both direct COVID-19 sensitivity as well as general economic sensitivity. For mall REITs, however, even solid economic growth and relatively strong growth in retail sales in prior years weren't enough to avoid a fourth straight year of underperformance in 2019.COVID impact on real estate

On that theme, the dismal reports from mall REITs come despite retail sales data that hasn't been nearly as bad as initially feared. In fact, aided by the WWII levels of fiscal stimulus over the last six months, retail sales jumped to all-time record highs on an annualized basis in September, regaining all of the lost ground during the pandemic. Naturally, e-commerce sales have led the charge this year, with online sales now higher by nearly 25% from last year, and brick-and-mortar sales are also now higher by 2.0% from last year. Experiencing sharp declines this year, however, has been the traditionally mall-based clothing, department store, and electronics categories.

Desperate times call for desperate measures, and we have been encouraged to finally see some "fight" and creativity from mall REIT executives over the past year after a decade of a seemingly "business-as-usual" strategy. Simon Property Group has been on a shopping spree, making investments into distressed retail brands, including Brooks Brothers, Lucky Brand, Forever 21, and J.C. Penney. A strategy that does have successful precedent - notably the acquisition of Aeropostale in 2016 - the investments will keep many storefronts open, at least for now. Even so, retail research firm Coresight Research expects that between 20,000 and 25,000 stores will close in 2020, with 55-60% of the store closures being mall-based tenants.

store closings 2020

Meanwhile, Simon's acquisition of fellow high-productivity mall REIT Taubman Centers remains in limbo after Simon attempted to pull out of its merger agreement in June, alleging that Taubman breached covenants of their merger agreement, specifically citing that TCO was disproportionately impacted by the pandemic and that it didn't take steps to mitigate the impact, an allegation that Taubman called "a classic case of buyer's remorse." Ultimately, market pricing still implies a high probability that the acquisition will eventually be completed. While we are skeptical that the lower-productivity enclosed mall format can remain viable over the next decade, we do believe that well-located high-productivity suburban malls that have the critical mass and "network effects" to offer a value-added retail experience can remain relevant.

retail competitive advantage

Mall REIT Investors On A Roller-Coaster Ride in 2020

Absent a miracle, mall REITs are likely to underperform the REIT average for the fifth straight year in 2020. These REITs were slammed harder than any other property sector amid the depths of the coronavirus pandemic, plunging by as much as 65% at the lows. Despite the vaccine-related bump this week, Mall REITs are the second-worst performing sector in 2020, with returns of -42.8% compared to the 13.9% decline on the Vanguard Real Estate ETF (VNQ) and the 10.0% gain on the SPDR S&P 500 Trust ETF (SPY), which has rebounded more than 50% from its lows in March.

mall REIT performance

Four of the eight mall REITs are lower by more than 65% this year including the two aforementioned REITs in bankruptcy which have plunged more than 90%. Taubman Centers remains the lone mall REIT in positive territory this year on Simon's plans to acquire the fellow high-productivity mall REIT. Since 2015, mall REITs have produced an annualized average total return of -10.4%, the worst among major property sectors during this time. Simon Property Group and Taubman Centers have been the best-performing mall REITs during this time, but have still produced negative annualized returns.

mall REIT performance 2020

Interestingly, the preferred securities offered by these mall REITs haven't been much safer for investors in 2020. Six of the eight mall REITs offer preferred securities, including one issue from Simon Property (SPG.PJ), two from Taubman Centers (TCO.PJ, TCO.PK), two from Washington Prime Group (WPG.PH, WPG.PI), three from Pennsylvania Real Estate Investment Trust (PEI.PB, PEI.PC, PEI.PD), and two from CBL & Associates Properties (CBL.PD, CBL.PE) and one from Brookfield Property REIT (BPYUP). Among these six mall REITs, their preferred securities are lower by nearly 50% this year, as the preferred dividends from CBL and PEI have been suspended, while those from WPG remain significantly in doubt.

mall REIT preferreds bonds

Mall REIT Fundamentals Go From Bad To Worse

As the lone sector to record a full-year of negative same-store NOI growth at any point within the last decade, mall REIT fundamentals were the weakest among real estate sector heading into 2020 before the outset of the pandemic. While the higher-productivity mall REITs generally managed to keep their heads above water amid the retail apocalypse, the water is clearly getting increasingly more treacherous. The three high-productivity mall REITs - SPG, TCO, and MAC - have reported an average 15.4% decline in same-store NOI growth through the first nine months in 2020, by far the worst on record for any of these REITs. The lower-productivity mall REITs - PEI, WPG, and CBL - reported a devastating -27.3% average decline in same-store NOI growth.

mall same-store NOI growth

All eight mall REITs withdrew full-year guidance amid the pandemic, which had initially forecast an average same-store NOI increase of 0.8%. Occupancy declined roughly 280 basis points year-over-year for high-tier mall REITs and dipped another 150 basis points for the lower-tier malls, and we think we'll likely see sector-wide occupancy dip below 90% by the end of 2020 given the jump in store closures in the back half of 2020. As noted above, FFO per share growth was even more ugly than the property-level metrics, as the mall REIT sector saw an average decline of more than 45% in Funds From Operations in the first half of 2020 compared to the same period last year.

mall REIT performance

Leasing spreads, perhaps the best leading indicator of NOI growth, continue to point to declining growth in the years ahead. Leasing spreads averaged -3.9% for the low-tier malls, but we have yet to hear 3Q results from CBL & Associates, which have been delayed due to their bankruptcy filing. The high-productivity REITs reported an average 3.5% decline in leasing spreads, matching the lowest in more than a half-decade while Tanger reported a 13.4% plunge in leasing spreads, by far its worst of all-time. We expect a continued decline for the balance of the year and likely well into 2021 as market rents trend lower amid a jump in store closings, and expect to see double-digit declines in spreads for low-productivity mall REITs in 2021.

mall leasing spreads

Mall REIT Valuations and Dividends

Mall REITs trade at some of the lowest valuations across the REIT sector, but while value-oriented and yield-seeking investors may be attracted to these REITs, we caution that the "deep value" strategy hasn't been particularly rewarding to REIT investors over the past decade. Mall REITs trade at a Price-to-FFO ("Funds from Operations") multiple of roughly 8.1x, which is below the REIT sector average of 20.0x. The sector now trades at a roughly 50% discount to Net Asset Value, though the "true" NAV discount may be far lower given the recent lack of private market buyers for enclosed mall properties.

mall REIT valuations

For the handful of larger REITs that have continued to pay their dividend, mall REITs have become one of the highest-yielding REIT sectors, but not necessarily for the right reasons. Helped by the large weighting to Simon Property Group, mall REITs pay a weighted average dividend yield of 5.8%, which is second only to prison REITs. In our recent report "The REIT Paradox: Cheap REITs Stay Cheap," we discussed our study that showed that higher-valued and lower-yielding REITs in faster-growing property sectors with lower leverage profiles have historically produced better total returns, on average, than their higher-yielding counterparts.

mall REIT dividendsAs noted above, five mall REITs - SKT, WPG, CBL, PEI, and TCO - have completely eliminated their dividend in recent months while two others - SPG and MAC - have reduced their dividend, and we believe that a reduction from BPYU is inevitable given the extended payout ratio. We continue to believe that mall REITs will be among the last to resume or increase their dividend above pre-pandemic rates given the precarious debt situation faced by all of these REITs. That said, we do see the current dividend by Simon Property as attractive and well-covered by FFO, assuming a base-case of a vaccine-driven recovery in mall traffic and stabilizing in fundamentals by early 2021.

mall REITs yield

Key Takeaways: Too Little, Too Late?

Pushed to the brink by the pandemic, Mall REITs entered 2020 on unstable footing following a tsunami of store closings over the past half-decade and a soon-arriving vaccine may be too-little-too-late for much of the sector. Despite improving rent collection and foot traffic, earnings results revealed that Q3 was another epically-bad quarter with same-store Net Operating Income plunging more than 20% and occupancy rates continuing to decline.

NOIPushed over the edge, troubled mall REITs Pennsylvania REIT and CBL & Associates each filed for Chapter 11 bankruptcy this month and one or two others may not be far behind. While the lower-tier of the sector is getting hollowed out and we continue to see insurmountable challenges for the Class B and C malls, the forthcoming post-pandemic "suburban revival" does offer a glimmer of hope for the higher-productivity mall REITs, including Simon Property and Brookfield Property for deep-value, contrarian investors.

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